Weekly brief

A Q1 EARNING SEASON LIKE NO OTHER

Two third of the S&P500 companies have now reported. Earnings are expected to settle at -14% in Q1 y/y, with the steepest drops in the consumer discretionary, financial, industrial, base material and energy sectors. Revenues would grow only 0.5% y/y, due to weakness in the same sectors. Margins would contract -2% y/y – especially for financials. Earnings and revenue surprises both stand below their long-term average, but not massively so: 65% of the reporting companies beat their EPS estimates by an average of 2% (vs. a long-term average of 70% of positive beat by 5%). Sharp EPS estimates revisions of -12% for Q1 (and -27% for 2020), that greatly accelerated since March, did lower the bar for surprise. Another major drop in profits is expected in Q2 (-42% y/y) followed by a recovery in H2, which would translate in a -23% full-year 2020 earning plunge, compared to 2019.

 

Given the level of uncertainty, trading volumes before report announcements were shallow and stock prices volatility was high, reflecting investors’ nervous wait-and-see stance. Once earnings were reported, extreme volatility and elevated trading volumes witnessed investors’ struggle to figure out fair prices. The limited number of companies issuing guidance did not help to this regard.

 

However, investors gave companies the benefit of the doubt, evidenced by stock returns after-reports outperforming the S&P500 over the same time frames. Moreover, with the earning season coinciding with a strong market rally, investors rewarded stock beating their estimates but did not heavily sanctioned misses. Beyond statistics, investors were particularly sensitive to liquidity ratio and business sustainability. Overall, stock returns overshot companies’ fundamentals on the upside, but not ridiculously so. While highly disconnected from companies’ fundamentals early in the season, stock prices traded more in line as the rally started to lose some steam.

 

Stock returns after reports were mainly driven by sector and broad market trends (which moved in tandem with trends regarding virus spreading, economic surprises, or authorities’ stimulus), not by idiosyncrasy. Besides, company-specific catalysts – including M&A, equity offering, and other corporate operations – were scarce. Amid extreme prices correlation and a growing infotech sector leadership, the room for pure stock-picking alpha was thin.

We find that energy, materials and industrial stocks probably offered the best alpha opportunities.

 

Considering the magnitude of the virus shock on corporate profits, the earning season was neither as disastrous as feared nor leading to complete irrational pricing. While providing limited single-stock opportunities, the Q1 earning season was not anomalous enough to lead to major alpha losses. Market timing (i.e. dynamic beta exposure) and sector arbitrage were the main differentiating factors among L/S Equity managers, especially in March. Since then, their performances strongly rebounded in April, up as much as +7% in aggregate, mostly thanks to their rising beta exposures. The fading correlation and dispersion across L/S Equity managers’ returns in April is consistent with normalizing trading conditions, boding better for alpha.